German IFO and UK Q2 GDP set to disappoint

Sentiment in Europe continues to deteriorate at a rate of knots with Spanish borrowing costs flattening out across the curve at unsustainably high levels, well above 6.5%. With signs of stress increasing, the 5 year yield is trading marginally above the 10 year yield, above 7.5%. This concern about Spanish solvency has also spilled over into Italy’s borrowing costs, sucking them higher as well, as local unrest in both countries against austerity continues to grow.

Rising concern about a likely Greece restructuring is also worrying markets, which would mean that the beleaguered country would likely need a further bailout. Initial findings from unnamed troika officials suggest that the debt sustainability analysis is way off track with the economy set to contract a further 7% this year alone.

Given that the current mood in Europe remains uncompromising with respect to an easing up in austerity, especially in light of Moody’s actions this week, fears are rising of an uncontrolled Greek exit, unless some form of compromise is reached. Moody’s followed up its action earlier in the week by also putting the existing bailout fund the EFSF, on rating watch negative as well.

Unfortunately the problems remain political given that now most of Greece’s debt isowned by the official sector, which essentially means any losses would be borne by
European taxpayers. Try selling that to hard pressed taxpayers when you want
to get re-elected, a real problem for the Netherlands with an election
September 12th and German Chancellor Angela Merkel who is looking to get
re-elected a year from now.

In any case the economic outlook doesn’t appear to be getting any better and continues to point to further weakness, as shown by yesterday’s poor French and German manufacturing PMI data which deteriorated even further in July, with German data hitting a three year low.

With this in mind it is unlikely that today’s German IFO business confidence data will do anything to assuage concerns about falling business confidence in the German economy. Expectations are for a further deterioration in the business climate from 105.3 to 104.50. IFO expectations are also expected to slide to 96.8 from 97.3. In the wake of Moody’s warning this week today’s 30 year German bond auction will be important with respect to investor appetite and yield. The previous auction saw a cover of 1.1 with yields of 2.41%.

For all the problems in Europe the UK is also finding life difficult with the latest figures for UK Q2 GDP set to be released later today. The figures from the ONS are expected to show that the UK economy remained in contraction for the third successive quarter, with a decline of 0.2% expected to follow the 0.3% contraction in Q1 and the 0.4% contraction in Q4 last year. Despite this the figures are likely to be more damaging politically than economically given that unemployment does appear to be slipping back and the various independent PMI data seen so far this year doesn’t appear to paint as bleak a picture as the headline rates suggest.

In any case today’s figures are expected to justify the arguments which prompted the decision by the Bank of England to pump an extra £50bn into the economy earlier this month, even if it remains questionable as to the efficacy of the asset purchase program since it was restarted last November. Let’s face it, since the program was restarted the UK economy by official measures, has contracted throughout 2012, so the net result of the program has been negative growth, hardly a ringing endorsement for the policy.

EURUSD – yesterday’s retest towards the 1.2140 gap saw the euro slip back and make another two year low yesterday at 1.2045 keeping is on course for a break below the 1.2000 level and a test of the 1.1880 2010 lows. A monthly close below 1.2150 is likely to be the catalyst for that though we should also be aware that the 200 month MA comes in at 1.2060. We are on course to post the lowest monthly close for six years. The gap between 1.2140 and Friday’s close at 1.2160 remains a key level with a move through 1.2170 needed to stabilise for a move towards the 1.2300 level. Only a break above this level targets 1.2520 the 55 day MA.

GBPUSD – the predominant range remains likely to hold sway here with resistance near the 200 day MA though Friday’s bearish daily candle reinforces the case for a test towards the recent range lows at 1.5270.To target a move towards 1.5910 we would need to see a close above the 200 day MA. Support remains around this month’s low at 1.5395, and then this years low at 1.5240. Only a close below 1.5240 signals a risk of a return to the July 2010 lows at 1.4950.

EURGBP – the failure to take out resistance at the 0.7830 level keeps the onus on the downside for further losses, however caution is the watchword with the bullish candle on Monday. Only a break above the highs last week at 0.7880 has the potential to stabilise. A break below the October 2008 lows at 0.7695 could well see a test of the 2008 lows at 0.7390.

USDJPY – the US dollar continues to slide back towards the 77.60 May lows and the base of the weekly cloud. As long as this holds the downside the risk of a rebound remains quite high. A move above the 79.30 level brings the 80.00 level back into play and then by definition the main resistance at the top of the weekly cloud at 80.45.

Positive Developments Hard to Come By

The cupboard has been bare this week when it comes to positive economic developments, with traders instead faced with underwhelming earnings in the US and more alarm bells ringing over Greece and Spain.

In the currency market, anything not named the US Dollar or the Japanese Yen have been staring at considerable selling pressure, with higher yielding currencies not being the most enticing place to be given the heightened alert status of financial markets so far this week.

The day has been nothing if not interesting for the Australian Dollar (AUD), with the currency trading indecisively on the back of the latest inflation print. The 0.5% reading was slightly below the 0.6% forecast, which saw the AUDUSD decline initially, however the Aussie was quick to bounce back and head north past the 1.02 level. It appears there was an initial misread by the market on what the result suggests for the August interest rate decision.

While the inflation reading leaves the door ajar for an August rate cut, the door is far from wide open as the result will likely give the RBA the luxury of maintaining a ‘wait and see’ approach over coming months. A softer reading closer to the 0.2% or 0.3% region would have been far more convincing in terms of RBA action in August than the actual 0,5% print witnessed today.

The IMF assessment of future Chinese growth also may have allayed some fears today and provided the AUD with some comfort, particularly coming on the back of Tuesday’s decent PMI reading. However if global equity markets continue the sell-off the AUD will be hard pressed to make it back to 1.03 this week, unless we see trading sentiment take a turn for the better.

Given there has been three consecutive sessions of triple digit falls on Wall Street, the Australian market was always going to face a tough task of making any sort of headway today. The buying momentum from last week has been replaced with heightened concern over the size of a potential Spanish bailout. Given the recent escalation in Spanish yields to extremely unnerving levels, it is starting to shape as a question of ‘when’ not ‘if’ a sizeable bailout will be sought. This scenario does no favours for ‘risk’ assets, which is why equity markets have floundered this week.

However all told, declines on the ASX200 today were quite shallow by the close. What is clear though is that the market is devoid of positive drivers and this was played out on the index performance today.